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Saturday, October 18, 2008

Something interesting is happening right now in the Gold and Silver market. The paper price has now disconnected with the physical price. The has happened because the paper market can be manipulated in the short term by large investment banks who have the ability to take massive short positions to drive down the price. It has also happened because institutions are selling everything they can right now to try to cover their losses on the assets they cannot sell(mortgage securities) because there is no market for them.

The spot paper price of silver right now is about $9.50. If you were to call a dealer and make a purchase to buy physical metal there would most likely be a delay because of the recent investment demand around the world. Although this is still just the early stages, people have begun rushing into the metals over the past three months as they began to understand and feel the debasement of their currencies.

Normally when the paper market has been manipulated over the past few years it has caused the speculators to get shaken off in fear and sell back their recent purchase. This time it has been very different. As the price has been driven down from about $19.50 in mid July, investors have purchased more and more each step of the way down. The only thing slowing the buying from being even more intense is that people cannot find silver right now. (Gold is in a similar position but not quite as intense as silver)

As people began to enter the market they will also do some research into what they are buying and they will discover how low worldwide above ground silver supplies are right now. (Currently hovering around 500 million oz., or about 1 year of suppy) Silver serves two roles, the first as an investment, and the second as an industrial good. It is used in thousands of different products and its industrial demand will continue to explode as China and India continue to develop.

If you can find physical silver right now you can sell it on ebay for about $20 an oz. If one were so inclined, they could establish a relationship with a commodities broker on the COMEX and purchase a mini contract (1000 oz) for about $9,500. ($9,600 with commissions) You could then take delivery of the metals and sell them into the market at double what you paid for it.

So one of two things will happen from here. China and India may decide that they do not want to continue to grow and become the center of the global economy and their demand will shut down. The demand from the public may stop due to the stronger value they feel in their currencies. (The Fed has now increased the size of its balance sheet by about 1 Trillion dollars over the past 6 weeks. Up until that point it was a total of $897 Billion.)

Or, the paper price is going to catch up with the physical price being set in the real market and possibly blow through it. Most contracts are rolled over month after month on the COMEX (Commodities Stock Market). What if someone wanted to take delivery and they found out that there was no silver supply? A few weeks ago two banks shorted an ENTIRE year's supply of silver. What if they had to cover those positions?

The COMEX would default on their contracts, and then you'd see some serious fireworks. Is that possible? It could happen at any moment. Remember though, we're still in the skepticism stage of this bull market so its going to continue to be a very bumpy ride for a while.

I ultimately see the price of gold going to around $5,000 and the price of silver at $200 during the euphoria stage. I think we'll see those prices sometime around 2011 or 2012, unless we have an early run on the dollar which, like the COMEX defaults, could happen any time. I think the true run on our currency will begin sometime during 2010 as both foreigners significantly slow their purchases of our debt, and the money being printed now starts to make its way into the cost of living. The public will begin buying gold first, but as the price of that begins to get very expensive ($2000-$4,000) they will turn their eyes toward silver as something they can afford. This is when silver will explode, and due to its much more limited supply than gold, (something people will begin to understand) $200 may be a very low target.

Wednesday, October 15, 2008

You probably would never guess it from reading these discussions on a day to day basis, but my ultimate investment goal is to generate as much yearly income as possible from owning apartment units. I have looked out over a 20 year time frame and have put together a strategy to accomplish that goal.

Gold is a horrible investment over the long term. It generates no income, no interest, and no dividends. Income is the reason stocks and real estate provide the absolute greatest investment over the long term. Real estate also provides amazing advantages with leverage and tax loopholes. Those two advantages are what makes real estate the greatest long term investment in my mind.

As we've discussed before, however, markets move in large secular cycles. We are currently in a period where American stocks and real estate will continue to fall in real value for the foreseeable future. There are periods throughout history where commodities become the best store of value, and they are usually when stocks and real estate are in a downturn.

I don't own gold, silver, oil companies, agriculture, ect. because I think they will be the best long term investment. I own those things because I think they will allow me to purchase the greatest amount of real estate when they peak in value and real estate has bottomed. When will that point be? Ah, that's the most important question, and that's the reason why I follow the market as closely as I do.

Every day something changes in the world to control that date. For example, if the government had not taken the extraordinary actions it has over the past twelve months we would be very close to a great buying opportunity for real estate. Stocks, real estate, and our currency would have all fallen in value considerably.

Real estate (residential) becomes a strong buy when the median price of a home in an area is at a level where the median public income can put down 20%, and have the mortgage only be 28% of their total debt. This is the level where the private market will lend to the public and feel confident with their return of investment. In most areas of the country prices would have to fall by at least 50% to reach that level. At these levels you can purchase real estate and rent it out with cash flow, making it a real investment and not just speculation.

The price of real estate is controlled directly by the amount of money you can borrow. This is what created the artificial bubble the past few years, and that artificial bubble still exists. The government is now holding it up with its take over of Fannie Mae and Freddie Mac. These entities will now buy mortgages from buyers who cannot afford to pay for them. Their job is now to keep real estate prices from falling, not to make homes more affordable. Prices falling to levels people could afford them would make them more affordable, but the government will not allow that correction to happen. (It still will happen, but only in the cost of everything else rising faster than the rise in real estate)

So what does all this mean? Things have changed considerably from where I saw them playing out a few years ago. The free market still exists except on a much larger level. What we are seeing now is the United States government standing behind all the bad debt, instead of the private sector who initially took on the risk. This means it will not be the private sector that loses value, but the credit rating of the United States who is now guaranteeing all of it. The losses will still be taken, but it will be shown in the value of our currency and the ability of our country as a whole to borrow.

This will push down the value of our currency, and greatly push down the value of our bonds, as countries demand a much higher interest rate to take the risk of borrowing from the United States. For the first time ever, investors are taking out insurance (Credit Default Swaps) to buy US treasuries. The basis points (cost) for investing in our country are now higher than investing in McDonalds and Exxon.

To go back to a previous analogy; instead of dumping the bad cargo off the ship and moving forward, the entire ship is now going to go down.

How does this change the big picture? It makes investing in gold, silver, oil producing companies, agriculture, ect., all that more appealing in the short term. The returns from these investments will now be much higher at the end of their run, but the period of transferring those gains into real estate will pushed a little further into the future. The swing will ultimately be greater, as commodities will ultimately go higher and real estate will ultimately fall further.

I'll have future discussions on the value of commercial real estate because it is a much different beast than residential and will need a more in depth analysis.

The markets were shocked this morning when the inflation numbers came out higher than expected. How could the cost of living be rising? The government is printing trillions of dollars with nothing backing their value and flooding them into the market. But this doesn't affect the United States, right? This only affects other countries that follow the same monetary policy.

If you drop a stone from a high building in New York City it will not fall, right? That only happens in other countries. There is no gravity in New York.

There was a funny interview last night on the Glenn Beck show. Two guests were being interviewed and one of them was trying to explain why printing trillions of worthless dollars will not affect our economy like it affects others that are doing the same thing, and all the other countries that have tried to do the same thing in the past.

He says, "our policy makers are smarter." What? Printing trillions of worthless dollars here has the same effect in our country as it does in others. A stone will will fall here, and hyperinflation is on its way.

Tuesday, October 14, 2008

In the past two years I have become a student of something called Austrian economics. It is a different type of economics than what is taught in schools and represents something of an old forgotten science. It allows the people who have mastered this science the ability to "see the future." I have not reached that point, but I study under certain economists you could consider jedi who wield this power. I hope to have an understanding close to theirs one day.

What is Austrian economics? In simple terms, it looks at the effect of market decisions that the public does not immediately see and thus people do not understand. The most simple example is the following:

A young boy is walking down the street and decides to throw a brick through the window of a baker's shop. A crowd gathers around the broken glass and looks in disgust at the the young boy's actions. The crowd immediately feels better, however, as one of the men in the group announces that at least the glass repair man will now have work. This helps our economy and they cheer the good news and go merrily on their way.

But what is the economic effect that is not immediately visible to them? The baker now has to pay the glass repair man $200 to fix the window. He was going to use that $200 to buy a new suit and he now cannot. The suit manufacturer is now out $200 because the baker does not have that money to buy it. The sum value is one less suit with the same glass we started with.

What is a better example in today's terms? Hurricane Katrina hit New Orleans a few years ago. It destroyed cities and recked homes. However, the press was relieved to hear that this destruction has created countless new jobs for people to clean up the city and rebuild those houses that were destroyed. It was an economic miracle!

So why does the government not just destroy towns all across the country? Wouldn't that be an efficient economy? Katrina was actually a boost to GDP based on the government's absurd numbers. The reason they don't is because of what you don't see. The money the government used to build Katrina back to where it was originally could have been used to build new factories that would build products we could trade with other foreign countries. That is true economic growth. Unfortunately, the country does not see or understand that. They only see the jobs created from the disaster. They don't see the factories because they were never there.

It is important to look at the actions the government is taking today with their bail outs from this Austrian point of view. The country cannot see the second effect from their irrational decisions. They only see their 401Ks rallying this week on the news that the government has now essentially nationalized every bank. Their homes go way up in value as the government restructures existing loans for people that are in foreclosure. It is an economic miracle!

If this is such a strong plan for our economy why was it not already in place to begin with? Why were all banks not always backed by the United States? If people could not pay their mortgages, why did the lenders not just pardon them all to begin with? Why wasn't the government buying toxic mortgage securities the entire time? Obviously, on the surface it looks very beneficial to our country, but no one ever looks at the secondary effect, the precession.

I know it's impossible to see now on the surface, but let me assure you, everything they are doing now will end up making things much, much, worse and may possibly send our country into a horrific place worse than anything I've described up to this point. A world in which all your remaining freedom is ripped from you, and you long for a day when stock prices falling was really not that bad._________________________

Sunday, October 12, 2008

A few weeks ago I said that I felt along with a few trillion in bailouts directly from the government, Fannie and Freddie would began to step up and loosen their lending restrictions. Well, not only have they done that, but they've taken it one step further by initiating a program to purchase toxic mortgage debt. Remember, the $700 Billion is what the public reads about in the news and gives them something to complain about. They still don't understand that their currency (their savings value) is being attacked by multiple villains. The Federal Reserve who now has increased its balance sheet 75% in the past three weeks, and the new face of Fannie and Freddie.

The pain from foreign markets around the world is caused by the fact that they lent us trillions of dollars that we spent on consumer items that we cannot pay back. What is important is understanding what will happen when all this smoke clears. They have solid economies based on production and savings. We have an economy that is based on them lending us money which we spend on cars, homes, and vacations.

As stock markets fall around the world it is presenting tremendous opportunities to purchase foreign stocks at bargain prices because of the forced irrational selling. (Discussed in the next discussion below) The American stock market is only just beginning to feel the true pain. The stock prices today reflect analyst's expectations of earnings from companies next year and the year after that. What they do not realize is that when the foreigners cut off our free money those earnings will not materialize, and our economy will be shown to the world as what it truly is; a house of cards.

You saw an interesting sign of this during last weeks trading. As tremendous money left the stock market, the treasury bond yields did not fall heavily as they have in the past. (Money was not moving back into treasuries as safety) This is an interesting signal of the lack of faith in the credit of the United States and is only a preview of what's to come. The bond market is the last great bubble to pop, and as interest rates finally begin their rise it will be the final nail in the coffin of the US economy.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.